P26-34B Using payback, ARR, NPV, IRR, and profitability index to make capital in
ID: 2533413 • Letter: P
Question
P26-34B Using payback, ARR, NPV, IRR, and profitability index to make capital investment decisions Splash City is considering purchasing a water park in Omaha, Nebraska, for $1,910,000. The new facility will generate annual net cash inflows of $487,000 for eight years. Engineers estimate that the facility will remain useful for eight years and have no residual value. The company uses straight-line depreciation, and its Stockholders demand an annual return of 10% on investments ofthis nature. Requirements 1. Compute the payback, the ARR, the NPV, the IRR, and the proftabilty index of this investment. 2. Recommend whether the company should invest in this project. -ARRANDVIRR and profitabilitvindex to make capitalExplanation / Answer
Computation of Payback Period
Initial Investment
$ 1,910,000.00
Expected Annual Cash Inflows
$ 487,000.00
Payback Period
3.92
Computation of ARR
Annual Cash Inflow (A)
$ 487,000.00
Depreciation (B)
$ 238,750.00
Annual Income (A-B)
$ 248,250.00
Acquistion Cost ( C )
$ 1,910,000.00
ARR (Annual Income/Acquistion Cost)
7.694
Computation of NPV
PVF@10%
PVF@20%
Cash Inflow
$ 487,000.00
$ 487,000.00
5.335
3.837
Present Value
$ 2,598,145.00
$ 1,868,619.00
Initial Investment
$ 1,910,000.00
$ 1,910,000.00
NPV
$ 688,145.00
$ (41,381.00)
Computation of IRR
IRR = Lower Rate + NPV (Lower Rate)/[NPV(Lower Rate) - NPV(High Rate)] X (High Rate - Lower Rate )
=10% + 688145 / (688145+41381) * 10%
=19%
Computation of Profitability Index
Pofitability Index = PV of Cash Inflow / Initial Investment
=2598145/1910000
=1.36
Computation of Payback Period
Initial Investment
$ 1,910,000.00
Expected Annual Cash Inflows
$ 487,000.00
Payback Period
3.92
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